Q: My mortgage lender has told me I will have to pay PMI. What is PMI?

A: If you’re planning to buy a home, you have probably heard the mortgage lender use the term PMI. PMI is an acronym for Private Mortgage Insurance. PMI is an insurance that is required to protect the lender in the case a borrower defaults on the loan in the event they are not paying at least 20 percent down on a property when obtaining a mortgage loan.

Basically, PMI is generally required when a borrower has less than 20 percent equity, which means the homeowner is putting less than 20 percent down.

And it is required if the loan is a refinance and the borrowers do not have 20 percent equity in the property as well. The cost of PMI increases as your down payment amount decreases. This is something the buyer has to consider when making a mortgage loan application. There are advantages and disadvantages of choosing PMI versus a larger down payment to avoid PMI. But the basic question is what makes people go for PMI?

PMI often helps borrowers to buy a house with a five percent or 10 percent cash down payment. For example, suppose you want to buy a house and obtain a mortgage loan at 95 percent of the cost of the house, the PMI would charge an insurance premium to be included in your monthly mortgage payment.

This PMI insurance premium would help to entice the mortgage lender to make the loan knowing they would be covered for the amount of the mortgage over and above the 80 percent amount.

In the event of default, the PMI insurer would make sure the lender received the amount of money in excess of 80 percent that was loaned to the borrower. This would allow the lender to sell the property to recoup their investment in the event of the borrower’s default and knowing this amount would be covered by the PMI insurer.

Most of the time, an advantage of PMI is that it builds the insurance into the monthly payment and allows the borrower to potentially get a tax deduction. Private mortgage insurance does not give you additional homeowners insurance, but it gives the mortgage lender insurance just in case you do not complete your duty by not paying your payments.

The best part is that you can cancel your PMI after you have achieved 20 percent equity, in most cases. Generally, you have the right to request cancellation of PMI when you pay down your mortgage to the point that it equals 80 percent of the original purchase price. Also, in some cases, lenders allow you to get an appraisal and show that the value is to a point that PMI is not necessary and you are allowed to end the payment of the PMI.

PMI has its disadvantages mostly because of the cost is associated with it. But, there’s no doubt that the advantages it has to a potential homeowner allowing them to purchase a home with a lower down payment. It has made it possible to dream for every American in the country.